Inflation and price level are topics mentioned in this section. Don't worry if you don't understand them yet, we will learn more about inflation on subtopic 3.2.
GDP and GNI values can be presented either as:
- Nominal values: measured in terms of prices that prevail at the time of measurement (not adjusted for inflation).
- Real values: taking the effect of inflation into account.
Nominal GDP and GNI may increase as a consequence of either:
- An increase in the real national output.
- An increase in the price level (inflation).
Utilising real values accounts for these increase in the price level of an economy, allowing to truly measure the increase in the national output. This allows economists to make comparisons of economic activity over time.
Calculating real GDP and real GNI using a price deflator
To account convert nominal values to real values, economists use a price deflator. A price deflator is:
- Comparing the average prices during a specific time period to the average prices in relation to a base year.
- Calculated statistically by economics experts.
- Used to adjust GDP and GNI to account for inflation.
The formula for the price deflator (in relation to a base year) is:
$$\text{Price Deflator} = \frac{\text{Nominal GDP}}{\text{Real GDP}} \times 100$$
This equation measures how much prices have changed relative to a base year.
NoteWhat is a base year?
The base year is a specific year selected as a reference point for comparison of economic data over time. During the base year:
- The GDP deflator is set to 100, ensuring that nominal GDP and real GDP are equal.
- It serves as the benchmark for calculating inflation-adjusted values in other years.
Therefore, to find real GDP, the following formula is used:
$$\text{Real GDP} = \frac{\text{Nominal GDP}}{\text{GDP Deflator}} \times 100$$
ExampleCalculating real GDP
Consider a hypothetical country, Econland, with the following data:
| Year | Nominal GDP (in billions) | GDP Deflator | Real GDP (in billions) |
|---|---|---|---|
| 2021 | $8,000 | 100.0 | $8,000 |
| 2022 | $9,200 | 115.0 | ? |
| 2023 | $10,500 | 130.0 | ? |
Real GDP for 2021 (base year)
Since 2021 is the base year, nominal GDP equals real GDP:
$$\text{Real GDP} = 8{,}000 \, \text{billion dollars}$$
Real GDP for 2022
Using the formula:
$$\text{Real GDP} = \frac{\text{Nominal GDP}}{\text{GDP Deflator}} \times 100$$
Substitute the values:
$$\text{Real GDP} = \frac{9{,}200}{115.0} \times 100 = 8{,}000 \, \text{billion dollars}$$
Real GDP for 2023
Using the same formula:
$$\text{Real GDP} = \frac{\text{Nominal GDP}}{\text{GDP Deflator}} \times 100$$
Substitute the values:
$$\text{Real GDP} = \frac{10{,}500}{130.0} \times 100 = 8{,}077 \, \text{billion dollars}$$
The process for calculating real GNI is identical, except it uses nominal GNI and the GNI deflator.
